New Law Could Help Students Erase Debt

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Ever heard of the the Private Student Loan Bankruptcy Fairness Act?

If you're in over your head on a student loan debt, it could help you wipe the slate clean — at a bargain-basement expense. Banks, however, may not take to the new law so well.

HR 5043 isn’t law yet. But it is being fast-tracked in Washington, with the bill being introduced in both the Senate and the House in late April.

The bill seeks to change the way creditors, borrowers and bankruptcy courts view student loans. Currently, both private and pubic student loans are treated like tax debts or child support debts — both of which are notoriously difficult to shed via bankruptcy proceedings. As recently as 2005, private student loans were much easier to bundle into a bankruptcy deal, but a key provision in the 2005 Bankruptcy Reform Act made it much more difficult to walk away from student loan debt.

If the legislation passes as is, private student loans would revert back to their pre-2005 status — and once again be easier to discharge in bankruptcy court. Federally-backed student loans, which have a lower average of default rates, wouldn’t be covered under the same statutes as private loans if the bill passes.

According to the U.S. Student Association, the average private student loan debt stands today at $25,000. Furthermore, the USSA estimates that there is an outstanding $730 billion in both private and public student debt today. Of that number, only 40% is “actively” being repaid.

The bills in Congress are targeting privately-funded college loans for a specific reason, advocates say. According to U.S. Rep. George Miller (D-Calif.), the chairman of the House education committee, private student loans are far riskier than government-backed loans. “Unlike federal student loans, which have a cap on interest rates and can have flexible repayment options for borrowers, private student loans have no interest rate cap and no cap on the total amount a student can borrow.”

Banks and other private lenders don’t like the bill. They point out that college graduates are far more likely to struggle paying back their loan debts than other borrowers. They’re willing to back college students, betting that their rising incomes in their 20’s and 30’s will result in the loan being paid back in full. But if college graduates can successfully discharge a student loan debt, then that risk to banks is greatly enhanced. Says Peter Warren, president of the Education Finance Council, a nonprofit student loan provider association, "Making all private student loans funded by nonprofits completely dischargeable in bankruptcy would raise financing costs, harming the ability of these public-purpose entities to continue to offer below market interest rates to borrowers.”

The bill will almost certainly gain ground in a Democrat-controlled Congress. But its chances of passage are no sure thing. Heavy lobbying by private lenders could dilute, or even kill the bill. But the bill does have the support of many consumer groups, and many colleges and universities.

One thing’s for sure — if the bill does pass, it will change the way private lenders issue student loans, making them much more selective. As HR 5043 winds its way through Congress, BankingMyWay will keep a close eye on its progress.

—For the best rates on loans, bank accounts and credit cards, enter your ZIP code at BankingMyWay.com.

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